Since the Great Financial
Crisis of 2007-09, policymakers
have sought to reduce systemic
risks in OTC derivatives markets by promoting the trading
of standardised contracts on
exchanges or organised trading platforms and their clearing
through central counterparties.

While this might have been
expected to lead to more trading on exchanges, the latest data
suggest that innovations in OTC
markets appear to have made
OTC instruments more attractive. For example, exchange-like
mechanisms have been introduced to trade OTC instruments,
most notably swap execution
facilities in the United States.

Central awareness

Also, a growing share of OTC
contracts is centrally cleared;
the part of the Triennial Survey
on outstanding amounts, to be
published in November 2016,
will provide comprehensive data
on central clearing for the first
time. Finally, dealers are compressing more and more OTC
instruments – that is, market
participants are working together to eliminate economically
redundant contracts and thereby
to reduce gross exposures.

Foreign exchange derivativescontinue to be traded over-whelmingly in OTC markets.The daily average turnover offoreign exchange derivatives inOTC markets exceeded $3.4 tril-lion in April 2016, comparedwith only $0.1 trillion tradedon exchanges (Graph B1, centrepanel). OTC markets dominateowing, in large part, to foreignexchange swaps. These arepopular as funding instrumentsbecause they do not change for-eign exchange exposures and socan be used to roll over hedges.

Moreover, OTC deals better serve
customised demands in OTC
markets, such as matching cash
flows on odd dates or trading
currency pairs not involving the
US dollar. In only three currencies do exchanges account for a
substantial share of FX derivatives activity: the Brazilian real,
Indian rupee and Russian rouble,
where exchanges accounted for

38%, 15% and 11% of turnover
in April 2016, respectively.

Increasing interest

Interest rate derivatives aretraded mainly on exchanges,but the share traded in OTCmarkets is increasing. The dailyaverage turnover of interestrate derivatives in OTC marketswas $2.7 trillion in April 2016,compared with $5.1 trilliontraded on exchanges. The pro-portion traded on exchangesdeclined from around 80% inthe 2000s to 67% in April 2013and to 66% in April 2016. Thisshift towards OTC markets isexplained partly by weak activ-ity in derivatives on short-terminterest rates, which dominatetrading on exchanges. The sus-tained period of low and stablepolicy rates in major economieshas reduced hedging and posi-tioning activity in short-termrates, especially in euro and yenrates. That said, while a matu-rity breakdown of OTC interestrate derivatives is not collected,various data sources suggest thatactivity across the term struc-ture is shifting gradually to OTCmarkets. Even at the long end,market participants appear to beswitching from contracts basedon government bond yields toones based on private yields,namely interest rate swap rates.

In emerging market economies, where activity is less likely
to be dampened by persistently
low policy rates, OTC markets
are driving activity upwards in
interest rate derivatives. The
turnover of interest rate contracts denominated in EME currencies rose from $177 billion
in April 2013 to $196 billion
in April 2016 when measured
at constant exchange rates,
although the US dollar value of
turnover fell owing to the depreciation of many EME currencies
against the US dollar. Over the
same period, the share of activity on exchanges fell from 58%
to 30%. The only EME currencies where exchanges accounted
for a sizeable share of activity
in interest rate derivatives were
the Brazilian real (86%), Korean
won (50%) and Chinese ren-minbi (32%). n